Investing; In Developing Countries, Prices May Be Right

By CONRAD DE AENLLE

Published: July 13, 2003

INVESTMENTS can be popular or cheap, but rarely both. Emerging markets today are one of the exceptions, in the view of many portfolio managers.

Professional investors around the world are heavily invested in the stock markets of developing countries. Forty-six percent of portfolio managers polled by Merrill Lynch in early June said they were overweight in emerging markets, meaning that they had a higher portion of their portfolios in these markets than would be suggested by a benchmark global index; 13 percent said they were underweight, while the remainder said their portfolio weighting was neutral.

The relatively large sums flowing into developing markets have helped them produce better returns than in larger ones. The global index of emerging markets compiled by Morgan Stanley Capital International returned 15.9 percent this year through June, compared with an 11.1 percent return for developed markets.

Latching on to a hot investment sector can be dangerous, but advocates of emerging markets say that even after considering their strong performance this year, shares in these markets still look less expensive than those in developed countries.

''They are cheap on a number of measures relative to their own history, relative to developed markets and on an absolute basis,'' said David Gait, a senior analyst specializing in emerging markets in the Edinburgh office of First State Investments, a fund management firm. ''It's not uncommon to find good-quality companies trading on single-digit price-earnings ratios, with double-digit growth rates and good and growing yields.''

Many of those companies are traded on American markets. Others can be bought only on local markets through global brokerage houses. Alternative investment routes include traditional mutual funds -- Morningstar has 163 in its database that focus on emerging markets -- and closed-end funds, which often trade at a discount to their underlying asset values. Some funds concentrate on single countries, others on regions or on emerging markets worldwide. In addition, there are many exchange-traded index funds, some focused on a broad range of emerging markets, and others on smaller geographic slices.

Sam Mahtani, who runs an emerging markets fund for F&C Management in London, said that based on estimated 2003 earnings, developing markets over all have been trading at a price-earnings ratio of about 10, roughly half that of the American market. ''That's a significant discount,'' he said, ''but where it gets more interesting is when you look at returns on equity.''

The typical publicly traded company in the developing world returns about 15 cents a year for every dollar of equity, he said. That is about the same as American companies, but by this measure, developing and developed markets have been heading in opposite directions. After the crisis of the late 1990's, when emerging markets in Asia and elsewhere experienced declining economies, currencies and share prices, their returns sank. In August 1998, Mr. Mahtani said, the returns on equity in the developing world were 7 percent, compared with more than 20 percent in the United States.

''The crisis forced policy responses from governments and the corporate sector because balance sheets were really bad,'' Mr. Mahtani said. ''That has led to significant increases in profitability and shareholder returns.'' Many American companies, meanwhile, are beset by sluggish growth and excess capacity in many industries.

Mr. Mahtani acknowledged that shares in emerging markets often trade at lower price-earnings ratios than those in developed markets, but said that the present gap was excessive, especially considering the progress made since the slump of the 1990's.

''We feel such a huge discount is unwarranted given the significant change in corporate and government balance sheets since the Asia crisis,'' he said. ''We do feel that emerging markets should trade at a discount to developed, but we feel a level of around 14 times earnings is more appropriate.''

Growth in emerging markets has been aided by the decline of the dollar. ''For many countries a weak dollar will help them to give a bit of internal stimulus to their economies, particularly to commodity exporters with U.S. dollar debt,'' he said.

Asia is a favored destination for fund managers. Mr. Mahtani prefers burgeoning consumer markets like India and South Korea. One of his fund's larger holdings is Reliance Industries, a diversified Indian holding company with extensive business in petrochemicals, a sector he likes. Another Indian company he owns is Ranbaxy Laboratories, a maker of generic drugs.

In Korea, which accounts for 21 percent of the fund's assets, the largest of any country, holdings include Kookmin Bank and SK Telecom. Both trade in the United States.

A European company Mr. Mahtani cited is Telekomunikacja Polska, the main Polish phone company. ''We're finding a lot of value in fixed-line incumbents,'' he said.

Hugh Young, head of global equities at Aberdeen Asset Management, expressed interest in an eclectic range of stocks. Among his preferred Asian investments are Samsung Electronics in Korea, which makes computer chips and electrical appliances; PetroChina, the Chinese national oil company; GAIL, a natural-gas company in India; Hyundai Motor in Korea; and China Mobile (Hong Kong), the subsidiary of a government-owned Chinese phone company.